100 Million Unnecessary Returns: A Simple, Fair, and Competitive Tax Plan for the United States by Michael J. Graetz (Yale University Press, 261 pages, $30.00)
Free Lunch: How the Wealthiest Americans Enrich Themselves at Government Expense (And Stick You With the Bill) by David Cay Johnston (Portfolio, 323 pages, $24.95)
There are two broad views of what we mean by tax reform. One school decries the complexity -- a byzantine tax code, impenetrable forms, public and private tax bureaucrats, and self-defeating or inefficient incentives that add up to sheer economic waste. The other school objects to who pays, reminding us that the rich have used their political influence to kill the system's progressivity, leaving ordinary taxpayers with too much of the bill. Both schools can agree that the system ought to be streamlined and that the complexity is often the consequence of special-interest provisions that harm economic efficiency as well as efficient tax collection.
In practice, however, the tax- simplification theme is often a political stalking horse for an even less equitable (though perhaps simpler) tax system. Proposals such as the Forbes flat tax, or the postcard-size tax return, or Gov. Mike Huckabee's proposal to abolish the IRS in favor of (what would be astronomical and regressive) national sales taxes invariably tout how simple they would be, but their deeper purpose is to reduce the share of taxes that the rich pay.
Michael Graetz's book, 100 Million Unnecessary Returns, is an intellectually serious and moderately conservative version of this first genre. At the heart of his plan is a 10 percent to 14 percent value-added tax (VAT) that would underwrite a general exemption of $50,000 for an individual and $100,000 for a couple or family. As a consequence, the 100 million households of his title would no longer file income-tax returns. His book is mostly about the purported benefits of the plan to simplification and to competitiveness, not the worsening regressivity.
By contrast, David Cay Johnston's Free Lunch is a shining example of the second school. In an era of over-caffeinated armchair pundits, Johnston is the rare old-fashioned reporter -- he covers taxes for The New York Times -- with a capacity for both investigative legwork and indignation on behalf of regular people. His previous book, Perfectly Legal, explores the Internal Revenue Service's losing war with ever more convoluted tax schemes, virtually all for the benefit of the wealthy. These schemes have shifted taxes onto moderate-income people while conveniently adding to the popular backlash against the IRS. Johnston shows why low-income people using the earned income tax credit are far more likely to be audited than rich people using baroque tax shelters. With audit resources restricted by a conservative Congress, the IRS can fathom the former but not the latter.
In Free Lunch, Johnston offers an appalling sampler of the other strategies used by the affluent to win tax breaks and other hidden subsidies at the expense of both the Treasury and the broad public interest. In one chapter, he explains how the tax code rewards America's large corporations for moving production abroad. As if it were not enough that the Chinese government offers huge subsidies and repressed workers,
A company with operations in the United States and another country can borrow money at home, deducting the interest and thus lowering American taxes. At the same time, it can earn interest on the untaxed cash it keeps overseas. So when an American company closes a factory here and moves it to China, provided it meets some technical rules, it can deduct the interest charges on its United States tax return while building up profits overseas that may never be taxed.
The tax treatment of U.S. foreign corporate profits is complex -- but who cares? Though the complexity serves incidentally as a full-employment act for a costly private bureaucracy of tax attorneys and accountants, the real function is reducing corporate taxes (and also subsidizing outsourcing). That's why corporations lobby for tax simplification about as often as cops get parking tickets. In a nice grace note, Johnston recalls the system's lineage. The treatment of foreign taxes was originally worked out by Herbert Hoover's Treasury secretary, Andrew Mellon, to reduce the big oil companies' American taxes while offering the Saudis stable royalties. As Johnston comments, "Adam Smith would not have approved."
In his well-researched and narrated stories covering more than a dozen facets of the subsidy-for-the-rich game, Johnston makes clear that the "complexity" of our tax system is not the result of tax bureaucrats, or wonky legislators, or big-spending liberals. Rather, it reflects elaborate schemes invented by wealthy people seeking to evade taxes or find other ways to underwrite private riches at public taxpayer expense. Johnston reminds us that complexity per se is a second-order problem. The primary problem is who pays and who benefits.
Graetz, a Yale law professor and former assistant secretary of the Treasury, downplays this key issue in 100 Million Unnecessary Returns. I admired his previous book, Death by a Thousand Cuts, co-authored with his Yale colleague Ian Shapiro. From this earlier volume, a superb case study of how the right had successfully demonized progressive taxation, I had mistakenly pegged Graetz as a process reformer and moderate liberal. I was curious to learn what kind of liberal case he might make for a VAT.
But 100 Million Unnecessary Returns, though ingenious, relies heavily on familiar conservative premises and rhetorical ploys. He begins by expressing alarm at the projected deficit. If the Bush tax cuts are allowed to expire in 2010, he writes, "federal revenues will exceed 20 percent of GDP, a level reached only once since World War II." But maybe we need federal revenues to exceed 20 percent of gross domestic product. Restoring a progressive income tax system to finance an adequate level of public outlay after decades of public neglect is an option not on Graetz's radar.
Worse, though the current deficit is clearly the result of deliberate policy choices by George W. Bush to reduce taxes on the rich and finance his war through borrowing, Graetz blames the deficit on generic irresponsibility of unnamed "politicians." Because future generations do not vote, Graetz contends, "deficit finance is catnip to politicians." But oddly, neither Bill Clinton nor the Democratic congressional majorities of the mid-1990s were susceptible to that catnip when they took political risks to balance the budget. The most elementary intellectual honesty by a Yale law professor would lay the blame for the deficit where it belongs.
Having begun with a misleading jeremiad against deficits, Graetz then offers a thoughtful discussion of the excessive use of tax deductions as instruments of public policy. But unlike Johnston (or parts of his own previous book with Ian Shapiro), Graetz once again does not cite the paramount source of the estimated $700 billion in revenues lost to tax expenditures -- the outsized political influence of financial elites.
Graetz also proposes to cut the already reduced corporate income tax rate even further, to the range of 15 percent to 20 percent, purportedly as a boost to competitiveness. As justification, he cites other advanced economies' lower corporate rates -- the unfortunate result of tax competition and the influence of Graetz's counterparts overseas. He also offers standard conservative alarms on Social Security and Medicare, which he says will have to be "trimmed," and he likes individual savings accounts as a substitute for part of Social Security.
Graetz makes four arguments for his value-added tax scheme. First, the federal tax code is too complex; second, government inefficiently pursues many social and economic objectives via tax subsidies instead of directly; third, our failure to have a VAT leaves U.S. industry at a competitive disadvantage; and finally, a VAT would increase savings rates. This is all true as far as it goes. He is also usefully and somewhat scornfully critical of the two competing conservative proposals, a national sales tax and a flat tax. However, his own preferred remedy, which he terms a "Competitive TAX," leaves much to be desired.
Graetz thinks he sees the elements of a grand bargain in a VAT. He quotes a marvelous line from Larry Summers that a VAT will be enacted as soon as Democrats recognize its potential as a money machine and Republicans realize it is regressive. Indeed, one can defend the regressivity of Europe's value-added taxes because the services they pay for are highly redistributive. By analogy, it might make great sense to have, say, a 10 percent to 14 percent value-added tax if it paid for national health insurance. Graetz's value-added tax, however, would neither add net revenues nor finance additional public services. It would replace a more progressive income tax with a far less progressive tax on consumption.
To make his VAT less regressive, Graetz would offer credits for people making under $30,000 a year (and require them to file a new tax form to receive the credits!). But the working middle class earning $30,000 to $100,000 would likely be socked with higher net taxes. And despite his erudition, Graetz doesn't bother to compute just how much more regressive the resulting system would be.
Would his proposal simplify the tax system, the premise for his entire scheme? Most tax complexity is the problem -- and the opportunity -- of those in the upper brackets. They are the taxpayers who make extensive use of shelters -- and under Graetz's plan they would still file income tax returns. For the rest of us, filing a tax return is just not that big a deal. The vast majority of people with earnings under $100,000 use the standard deduction. Even for those moderate- income people who itemize, it's a matter of keeping decent financial records and perhaps paying a few hundred dollars to a tax-preparer. As Graetz admits, getting rid of the tax expenditures that cause the worst complexity (and regressivity) is a political problem. If Congress can muster the political will to render the income tax simpler and fairer with the addition of a VAT, it can do so without one.
The next president will need to make the tax system simpler and fairer for three big reasons: to restore fiscal balance, to raise adequate funds for public needs, and to restore trust in the tax system itself. The best way to achieve those goals is not to add a VAT but to restore progressive rates and repeal tax preferences that cause most of the system's complexity, regressivity, and failure to collect adequate revenues.